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Do Taxes Explain European Employment? Indivisible Labour, Human Capital, Lotteries and Savings

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  • Ljungqvist, Lars
  • Sargent, Thomas J

Abstract

Adding generous government supplied benefits to Prescott's (2002) model with employment lotteries and private consumption insurance causes employment to implode and prevents the model from matching outcomes observed in Europe. To understand the role of a 'not-so-well-known aggregation theory' that Prescott uses to rationalize the high labour supply elasticity that underlies his finding that higher taxes on labour have depressed Europe relative to the US, this paper compares aggregate outcomes for economies with two arrangements for coping with indivisible labour: (1) employment lotteries plus complete consumption insurance, and (2) individual consumption smoothing via borrowing and lending at a risk-free interest rate. The two arrangements support equivalent outcomes when human capital is not present; when it is present, allocations differ because households' reliance on personal savings in the incomplete markets model constrains the 'career choices' that are implicit in their human capital acquisition plans relative to those that can be supported by lotteries and consumption insurance in the complete markets model. Nevertheless, the responses of aggregate outcomes to changes in tax rates are quantitatively similar across the two market structures. Thus, under both aggregation theories, the high disutility that Prescott assigns to labour is an impediment to explaining European non-employment and benefits levels. Moreover, while the identities of the non-employed under Prescott's tax hypothesis differ between the two aggregation theories, they all seem counterfactual.

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Paper provided by C.E.P.R. Discussion Papers in its series CEPR Discussion Papers with number 6196.

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Date of creation: Mar 2007
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Handle: RePEc:cpr:ceprdp:6196

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Keywords: aggregation theories; employment lotteries; human capital; indivisible labour; labour supply elasticity; labour taxation; social and private insurance;

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Cited by:
  1. Stéphane Auray & Samuel Danthine, 2008. "Bargaining Frictions, Labor Income Taxation and Economic Performance," Working Papers, Universidad de Málaga, Department of Economic Theory, Málaga Economic Theory Research Center 2008-1, Universidad de Málaga, Department of Economic Theory, Málaga Economic Theory Research Center.
  2. Mathias Trabandt & Harald Uhlig, 2012. "How do Laffer curves differ across countries?," International Finance Discussion Papers, Board of Governors of the Federal Reserve System (U.S.) 1048, Board of Governors of the Federal Reserve System (U.S.).
  3. Per Krusell & Toshihiko Mukoyama & Richard Rogerson & Aysegul Sahin, 2008. "Aggregate Implications of Indivisible Labor, Incomplete Markets, and Labor Market Frictions," NBER Working Papers 13871, National Bureau of Economic Research, Inc.
  4. Claudio Michelacci & Josep Pijoan-Mas, 2007. "The Effects Of Labor Market Conditions On Working Time: The Us-Eu Experience," Working Papers, CEMFI wp2007_0705, CEMFI.
  5. Erling Holmøy, 2014. "The equilibrium relationship between public and total employment. The importance of endogenous non-labour income," Discussion Papers, Research Department of Statistics Norway 779, Research Department of Statistics Norway.
  6. Per Krusell & Toshihiko Mukoyama & Richard Rogerson & Ayşegül Şahin, 2010. "Aggregate labor market outcomes: The roles of choice and chance," Quantitative Economics, Econometric Society, Econometric Society, vol. 1(1), pages 97-127, 07.
  7. Trabandt, Mathias & Uhlig, Harald, 2011. "The Laffer curve revisited," Journal of Monetary Economics, Elsevier, Elsevier, vol. 58(4), pages 305-327.
  8. Richard Rogerson & Johanna Wallenius, 2007. "Micro and Macro Elasticities in a Life Cycle Model With Taxes," NBER Working Papers 13017, National Bureau of Economic Research, Inc.
  9. Laun, Tobias & Wallenius, Johanna, 2013. "Social Insurance and Retirement: A Cross-Country Perspective," Working Paper Series in Economics and Finance 744, Stockholm School of Economics.

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